An Innovative Way to Prevent Adversarial Supplier Relationships
The economic impact of the pandemic and the uncertainty about what lies ahead are having a major impact on relations between companies and their suppliers.
For procurement professionals at large multinational companies, the temptation is to use their company’s clout to pressure suppliers to reduce prices. And when the supplier has the upper hand, it is hard to resist the opportunity to impose price increases on customers. Witness how the shortage of personal protective equipment (PPE) and ventilators led to skyrocketing prices.
Despite the short-term benefits, companies should resist employing these strategies because they will likely suffer the consequences later. The reason is shading — a term coined by one of us (Oliver) and John Moore. Shading happens when one party isn’t getting the outcome it expects and feels the other party has not acted reasonably. The aggrieved party will react by becoming less cooperative and less proactive in meeting the other’s needs (e.g., helping to meet sudden shifts in demand that would entail actions not spelled out in the contract, or imposing higher prices when the business climate shifts and it has the upper hand).
A better alternative is formal relational contracts that are designed to keep the parties’ expectations continuously aligned. This kind of agreement is a legally enforceable written contract (hence “formal”) that puts the parties’ relationship above the specific points of the deal. The parties embrace the fact that all contracts are incomplete and can never cover all the contingencies that may occur. This time it is a pandemic. Next time it will be something else.
The contract includes shared goals and objectives, guiding principles, and robust relationship-management processes, which spell out how the parties will work through issues as they arise. The guiding principles contractually commit the parties to use proven social norms (e.g., treating each other with honesty and in an equitable fashion), which ensure that the parties will refrain from short-term opportunism. The contract is not something the parties simply put in a drawer and pull out when something goes wrong; rather they view it as a playbook for working through issues fairly and flexibly.
Does it really work? The short answer is yes, a number of companies are successfully using it. In an earlier HBR article we shared the economic theory and applied research that support its adoption. The main example in that article, which appeared before the pandemic materialized, was a formal relationship between Vancouver’s Island Health Authority and South Island Hospitalists, a group of physicians who care for patients with the most complex medical issues at the authority’s two largest hospitals.
The parties’ labor services contract is anchored in a formal shared vision: “Together, we are a team that celebrates and advances excellence in care for our patients and ourselves through shared responsibility, collaborative innovation, mutual understanding, and the courage to act in a safe and supportive environment.”
The contract also includes six guiding principles, which obligate the parties to make “what’s in it for we” decisions. For example, one on equity states: “We are committed to fairness, which does not always mean equality. We will make decisions based on a balanced assessment of needs, risks, and resources.”
We recently interviewed both Island Health administrators and the hospitalists to see how they have fared during the pandemic. Specifically, were they living into the intentions and guiding principles they put in place as part of their formal relational contract? Did the mechanisms established in their contract help them work through the issues raised by the pandemic in a fair and flexible manner?
They told us that when the pandemic hit their region in March 2020, the Island Health system was suddenly faced with a dramatic change in its patient mix. The total patient count dropped 60% as the health system postponed elective or non-urgent procedures to mitigate the spread of Covid-19. Even though the physicians needed to manage fewer cases, those patients were higher risk, on average, than those they handled in normal times.
The impact on the budget and workload was drastic. The existing scheduling formulas did not work in the new environment; questions such as who would get to work which hours and who would have to work in the new high-risk Covid-19 ward were front and center.
Here’s how Island Health and the hospitalists dealt with what could have been a contentious situation. First, the parties approached their contract as a flexible framework. Rather than turn to classical us-versus-them negotiations, they used their shared vision and guiding principles to address the challenges: the sudden drop in the hospitalist hours that the health system required and keeping hospitalists safe and employed so they would be able to respond to future needs.
In accordance with a guiding principle concerning autonomy, the hospitalists took responsibility for tackling this scheduling challenge. Their solution: Every hospitalist would reduce his or her hours, but no hospitalist would lose his or her job. Part of the process included banking hours, which could be used, for example, if a fall Covid-19 surge occurred. In addition, the parties expedited the implementation of a new program they had been planning before the pandemic hit, which entailed the hospitalists seeing patients in their homes. All admit such innovations and flexibility would never have been possible under their previous conventional contract.
In another recent example, a formal relational contract helped a pharmaceutical company and a firm that provides services to its facilities. When the pandemic forced the pharma company to send employees home, the need for services such as cleaning and dining virtually evaporated.
Had the pharma company and facilities services company had a conventional contract, the former would have undoubtedly slashed payments to the latter. But their formal relational contract led them to try to find solutions that would balance the needs of both. Collectively, they came up with dozens of ideas. For example, one win-win idea to prevent the furloughing of dining service employees was to have them provide tailored meal services for the scientists who were working around the clock to develop a Covid-19 vaccine. Another solution included pulling forward required maintenance initiatives that had been budgeted but not yet been scheduled. As a result, the two companies will emerge from the pandemic with a stronger, not a weaker, relationship.
Given the uncertainty that lies ahead, it is especially important now that companies try to avoid antagonizing the members of their ecosystems. Formal relational contracts, which can turn adversarial relationships into mutually beneficial partnerships, is a proven means to such an end.
This content was originally published here.